Use of weighted average basis for fungible rights and obligations

Forex regulations have been made which may allow for an alternative to the first-in first-out (FIFO) method to be used when calculating forex gains and losses arising from a forex realisation event (FRE) 1, 2 or 4 for fungible rights and obligations.

Using a weighted average basis

The translation of foreign currency amounts into Australian dollar amounts may be made by using a weighted average basis provided an election is made.

This basis cannot be used where a retranslation election has been made. A retranslation election must be withdrawn before a weighted average basis can be used.

Where a weighted average basis is applied to a foreign currency denominated bank account which was subject to the FIFO method or retranslation, the opening balance should reflect the amount that is, or would, be the closing balance under those methods.

A weighted average basis can be calculated using a per-transaction method or an entire-year-of-income method. Either method is acceptable providing it is used consistently. However, the entire-year-of-income method is not appropriate where the fungible thing changes from a right to receive foreign currency to an obligation to pay foreign currency (or vice versa). This will occur, for example, where a bank account denominated in foreign currency moves from a credit balance to a debit balance.

Method 1: Weighted average basis per-transaction method

For a bank account with a credit balance, a weighted average basis calculation is required for each withdrawal. The cost of each withdrawal is calculated by taking the weighted average of all deposits made into the account up to the time of withdrawal.

A similar calculation is required where the bank account has a debit balance (for example, a bank overdraft facility). In these circumstances the cost of each deposit is calculated by using the weighted average of all withdrawals made up to the time of the deposit.

Method 2: Weighted average basis entire-year-of-income-method

For a bank account with a credit balance, a weighted average basis calculation is determined by taking the weighted average of all deposits made into the account during the entire year of income.

For a bank account with a debit balance (for example, an overdraft facility), a similar calculation is required to ascertain the cost for each deposit. This is calculated by taking the weighted average of each withdrawal made from the account during the entire year of income.

It is not appropriate to use the weighted average basis entire-year-of-income method where the balance of the bank account moves from a credit balance to a debit balance or vice versa.

Example 1: Weighted average per-transaction method

A foreign currency bank account opened on 1 September 2004 had the following transactions:

Date

Deposit ($US)

Withdrawal ($US)

Account balance ($US)

Exchange rate 1$A = $US

1 September 2004

$1,000

$1,000

$0.7200

15 September 2004

$2,500

$3,500

$0.7000

30 October 2004

$1,000

$2,500

$0.7300

31 December 2004

$3,000

($,500)

$0.7500

15 March 2005

$1,600

($2,100)

$0.7800

30 May 2005

$1,200

($900)

$0.7600

Total

$4,700

$5,600

The weighted average calculation is made at the time each transaction brings about either a cessation of a right to receive foreign currency (FRE 2) or an obligation to pay foreign currency (FRE 4). This is at the time funds are withdrawn or deposited.

The Australian dollar equivalent (ADE) of the amount deposited and withdrawn from the account is:

When $US3,000 is withdrawn from the account having a balance of only $US2,500, the entire amount of $US2,500 ($A3,543.09) is reduced to nil. The account changes from a credit balance of $US2,500 to a debit balance of $US500.

The cost of the withdrawal of $US3,000 comprises two parts:

(a) The ADE for the reduction of the $US 2,500 balance

$A3,543.09

(b) The ADE equivalent of the balance of $US500 at $A1=$US0.7500

$A 666.67

Total

$A4,209.76

The forex realisation loss brought to account under FRE 2 is

ADE of withdrawal of $US3,000

$A4,000.00

Less: Weighted average ADE cost of $US3,000

$A4,209.76

Forex loss

$A 209.76

Calculation 3 – FRE 4 arising from deposit of $US1,200 on 30 May 2005

The withdrawals made from the account up to 30 May 2005 are:

Date

Deposit ($US)

Deposit ($A)

31 December 2004 (to the extent of the balance of the account)

$500

$666.67

15 March 2005

$1,600

$2,051.28

Total

$2,100

$2,717.95

The weighted average ADE cost of the amount deposited ($US1,200) is calculated as follows:

= $US1,200 / $US2,100 = $A1,553.20 $A2,717.95

The forex realisation loss brought to account under FRE 4 is

Example

ADE of deposit of $US1,200

$A1,578.95

Less: Weighted ADE cost of $US1,200

$A1,553.20

Forex loss

$A 25.75

Example 2: Weighted average-per year of income

A foreign currency bank account opened on 1 September 2004 had the following transactions:

Date

Deposit ($US)

Withdrawal ($US)

Account balance ($US)

Exchange rate 1$A = US$

1 September 2004

$1,000

$1,000

$0.7200

15 September 2004

$2,500

$3,500

$0.7000

30 October 2004

$1,500

$2,000

$0.7300

31 December 2004

$500

$2,500

$0.7500

15 March 2005

$1,600

$900

$0.7800

Total

$4,000

$3,100

Under this method, the weighted average cost of all withdrawals in a year of income is arrived at by calculating the weighted average cost for all deposits made into the account during the year of income.

The Australian dollar equivalent (ADE) of the amount deposited and withdrawn from the account is:

Date

Conversion

Deposit ($A)

Withdrawal ($A)

1 September 2004

1,000 0.7200

$1,388.89

15 September 2004

2,500 0.7000

$3,571.43

30 October 2004

1,500 0.7300

$2,054.79

31 December 2004

500 0.7500

$666.67

15 March 2005

1,600 0.7800

$2,051.28

Total

$5,626.99

$4,106.07

As the account was opened in the year, the weighted average ADE cost of the amount withdrawn in the year of income ($US3,100) is calculated as follows:

= $US3,100 / $US4,000 = $A4,360.67 $A5,626.99

The forex realisation loss brought to account under the weighted average per year-of-income-method is

ADE of withdrawal of $US3,100

$A4,106.07

Less: Weighted average ADE cost of $US3,100

$A4,360.67

Forex loss

$A 254.60

End of example

Making an election to use the weighted average basis

An election to use a weighted average basis must be in writing and specify that it will commence from:

the day the election is made

1 July 2004; or

if the election is made by 26 July 2005, the applicable commencement date.

and must also state that it applies to:

all fungible things (to which the election is capable of applying); or

one or more specified classes of fungible things (if this is reasonably expected to reduce compliance costs); or

one or more specified fungible things if this would be consistent with their treatment by the entity in their accounting records and those records are prepared in accordance with generally accepted accounting principles (GAAP).

The election does not need to be lodged with the Tax Office.

Example:

This choice is made under Subregulation 775-145.01(4) of the Income Tax Assessment Amendment Regulations 2005 (No 2).

I, Joe Taxpayer, choose to use a weighted average basis for the following bank accounts with effect from today:

Financial Institution

Account Name

Account Number

XYZ Bank

Joe Taxpayer

123 456 789

ABC Credit Union

Joe Taxpayer

987 654 321

Joe Taxpayer

19 January 2004

End of example

Information on using a weighted average basis to translate foreign currency amounts into Australian dollar amounts. NAT 13596

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